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April 3, 2014

Can Another Detroit-Style Pension Crisis Be Avoided?

Reform, not financial maneuvering, will solve U.S. public pension crisis

There are four pillars to a well-funded retirement, the Geneva Association says.

Detroit’s ballooning deficits and large pension shortfall in December made it the largest U.S. city so far to become legally eligible for Chapter 9 bankruptcy.

It was emblematic of the growing crisis facing state and municipal pensions systems across the country. States have posted funding shortfalls of more than $1 trillion.

A new analysis by The Geneva Association, an international insurance economics think tank, suggests that nonpayment of annual required contributions and excessive reliance on single sources of funding in pension planning are among the biggest challenges to overcome.

The report references a 2010 report by the Pew Center on the States, which found that the huge shortfall facing state and local retirement systems was due to policy choices and a lack of fiscal discipline, namely, failure to make annual payments for pensions systems at actuarially recommended levels and expanding benefits without considering their long-term costs.

Thirty-four states had a funding level below 80%, Pew reported.

Financing retirement is an ever-growing challenge because of higher life expectancy and low fertility rates. The Geneva Association noted it had long advocated a four-pillar approach to sound pension planning:

A universal public system such as Social Security

An occupational pensions system supported by employers under government financial supervision

Private savings using financial intermediaries

Continued employment through the removal of barriers to partial employment of retirees.

The analysis found that excessive reliance on one of the four pillars — particularly a public system or private savings only — strained public finances or an individual’s ability to finance retirement adequately.

It also highlighted the unnecessary losses of human capital resulting from restrictions on the employment of retirees. Human capital, the ability to earn income, should be valued, particularly in societies with aging populations, the think tank said.

In contrast, the report said, a four-pillar structure offers a balance between socially desirable, yet socially costly, income protection benefits (first and second pillars) and realistically priced benefits that are potentially unaffordable to poorer workers (third and fourth pillars).

The report said the solution the U.S. public pensions crisis would not come from financial operations, but must come from real reform.

“[A solution] must come from real reform that at least lowers or eliminates bankruptcy costs and establishes better governance,” the study’s author Krzysztof Ostaszewski, actuarial program director at Illinois State University, said in a statement.

“The ultimate fate of public pension plans in the U.S. depends on the willingness of plan sponsors to pay for them.”

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